S&P Agrees To $1.4B Settlement Of Deception Charges That Started In Connecticut

Connecticut Attorney General George Jepsen speaks at a news conference with Attorney General Eric Holder at the Department of Justice on Tuesday, Feb. 3, 2015 in Washington. (Kevin Wolf / Associated Press)

Standard & Poor's has agreed to pay $1.375 billion to the U.S. government and 19 states to settle charges it misled investors when it issued positive ratings on shaky mortgage-backed securities in the lead-up to the 2008 financial collapse — a case first brought by the Connecticut attorney general.

The deal, announced in Washington, D.C., Tuesday by U.S. Attorney General Eric Holder with Connecticut Attorney General George Jepsen at his left, gives Connecticut $36 million.

Advertisement

It ends a case in which S&P was accused of caving in to investment banking clients who issued the securities, delivering rosy ratings on the securities out of zeal to win more work.

"For the first time a Wall Street ratings firm has been held accountable for its role in causing the 2008 financial collapse," Jepsen said at the podium. "And the message is clear: No business is too big, deep-pocketed, or politically connected to escape responsibility for its misconduct."

This lawsuit, which unearthed a record 290 million documents, was not the only one filed against Standard & Poor's Financial Services and other rating agencies as a result of the U.S. financial meltdown. But it succeeded while other efforts failed, in part because of a strategy devised in Connecticut.

Dozens of private lawsuits by hedge funds and pension funds alleged, for the most part, that Standard & Poor's was negligent and knew or should have known that it was deceiving buyers who counted on its ratings. Standard & Poor's, a unit of McGraw-Hill, successfully defended its actions under its First Amendment rights.

Their defense, Jepsen said, was basically: "'You didn't have to take our advice. We're sorry that we were wrong but we're entitled to have our opinions.'"

By contrast, the case in Connecticut — a legal ploy dreamed up in 2009 by George O'Connell and developed along with Matthew Budzik, both assistant attorneys general under former Attorney General Richard Blumenthal — relied on state laws that bar deceptive sales. It alleged that Standard & Poor's incorrectly claimed to users of its ratings that the ratings were objective, not swayed by conflicts such as its desire to win business from the firms issuing the bad securities.

Blumenthal brought the lawsuit in March 2010 and was followed by Mississippi, then Illinois, then in early 2013, by the U.S. Department of Justice and other states.

"The legal theory that was concocted out of 55 Elm St., brilliantly developed, I should say, is an unfair trade practices case," Jepsen said, naming the address of his office in Hartford. "We were fighting way above our weight."

By 2009, the toxic securities were famous. They relied on monthly payments on millions of mortgages that were given to home buyers with poor credit. They were packaged together by investment banks and sold to state pension funds and other investors.

Standard & Poor's admitted no wrongdoing in the settlement but agreed to abide by the trade practice laws of the various states and the federal government and monitoring for five years. S&P also agreed to a lengthy set of facts that could be read to show the firm compromised its ratings in order to maintain revenues.

Connecticut is among the states that have also sued Moody's Investors Service under the same strategy. That case, filed by Connecticut at the same time as the Standard & Poor's complaint, has been delayed by a judge, pending the outcome of the S&P case. "We will be turning now to re-engage with Moody's," Jepsen said, declining, in a conference call with reporters, to answer other questions about that case.

In the S&P settlement, the U.S. government will receive a fine of $687.5 million; 19 states and the District of Columbia will receive the same amount. Connecticut's share is about $14 million larger than it would have been if it were not a lead plaintiff in the case, Jepsen said.

McGraw-Hill also announced that the company had reached a $125 million settlement over similar charges with the California Public Employees Retirement System. "The Company and S&P Ratings take compliance with regulatory obligations very seriously and continue to make investments in people and technology to strengthen controls," McGraw-Hill said in a written statement about the settlements.

States may use the money as they choose; Connecticut will apply its part to the general fund, Jepsen said — pointing out that he "gently reminded" his former colleagues in the state legislature that the amount is larger than his department's $30 million annual budget.

Advertisement

Settling made more sense than fighting in court, Jepsen said. The $1.375 billion is larger than the profit that Standard & Poor's realized from the ratings on the targeted securities.

Although the settlement comes nowhere near the losses sustained by investors and the economy as a whole as a result of the collapse of collateralized debt obligations and bond tranches backed by subprime mortgages, those losses could never be recouped. The case did not attempt to quantify direct pension fund losses.

Blumenthal, now a U.S. senator, issued a statement Tuesday saying, "I am proud that Connecticut was the first state to hold these rating agencies accountable, and hope and expect that this $1.375 billion settlement will enforce a new era of responsibility in this industry."

Jepsen broke into a sweat and was a bit wobbly at the press conference, the result of a queasy stomach, he said later. But he was firm in his message throughout the day. "I would hope that Standard & Poor's and any other interested ratings agencies … would think twice about doing what they did again."

More likely, the case is part of a never-ending cat-and-mouse game in which Wall Street firms get away with what they can. The U.S. Securities and Exchange Commission issued rules last summer under the Dodd-Frank financial reforms that directly addressed the sorts of conflicts the agencies faced. We now await the next form of deception.